Found love again? The inheritance tax loophole that could cut your bill

If you want to remarry, this could ensure that the taxman can’t touch a larger portion of your estate.

Inheritance tax may be one of the nation’s most hated levies, but there’s no doubt that the Treasury is a big fan.

A massive £5.2bn was collected in inheritance tax receipts in the 2017/18 tax year, a new record, having jumped by 8% on the previous year.

There are plenty of reasons why more and more of us are getting stung with this tax - rising property prices being chief among them - but there are also a host of perfectly legal steps you can take in order to reduce the amount of tax your estate eventually pays after you die.

However, some of them are better known than others.

Inheritance tax and married couples

You only pay inheritance tax if your estate is valued at more than £325,000 after you die. It is then charged at 40% on the value of the estate above that threshold.

If you are married or in a civil partnership, then you can transfer your allowance to your partner upon your death. So essentially the surviving partner has a £650,000 allowance before they have to pay any inheritance tax.

This wasn’t always the case though. This transferral of allowances between partners was only introduced a decade ago. Before that, couples who wanted to reduce their tax bill would look to discretionary trusts as a way of doing so. And while this practice has rather died off since, accountants and tax experts point out it can still be an effective tool, particularly if a widow or widower goes on to remarry.

What is a discretionary trust?

First of all, it’s worth taking a quick look at just what a discretionary trust is.

When you set up a discretionary trust, you name trustees who run the trust, and beneficiaries who will benefit from the trust. It’s completely up to the trustees to decide which beneficiaries get what.

This flexibility is pretty useful when the person setting up the trust knows who they want to benefit from those assets, but don’t know exactly how they want to divide up those assets.

The other big selling point is of course that the trust assets are classed as being outside of the beneficiaries’ estate when it comes to inheritance tax.

How can this help for remarrying couples?

These discretionary trusts can be utilised in order to increase the size of the estate which will fall outside of the taxman’s clutches in the event of a remarriage.

It’s easiest to outline this using an example. Brian and Betty enjoy a long marriage, and when Betty dies she passes on her full inheritance tax allowance to Brian, giving him £650,000 before his estate is subject to the tax.

Brian later marries Jean, and places the £650,000 into a discretionary trust for her. Jean puts her existing £325,000 allowance into a separate discretionary trust for Brian. Essentially by doing so, the surviving partner will be able to pass on £975,000 without the taxman taking a slice.

Surely things can be simpler than this?

Earlier this year Philip Hammond, the chancellor of the exchequer, tasked the Office of Tax Simplification (OTS) with reviewing the inheritance tax system to see if there are ways that it can be cleaned up.

Perhaps unsurprisingly, in its call for evidence, the OTS said that it had received a greater response for this topic than in previous reviews of other taxes, a good insight into just how emotive a subject inheritance tax truly is.

Its initial report looked primarily at the administrative side of the tax, and found that the process is “complex and old fashioned”. Its next report, due next Spring, will look at other areas of concern related to the tax.

We can only hope that it comes through with some sound recommendations, and that the government acts on them. The current situation, where people and their accountants hunt for loopholes in order to reduce their liability, is far more complicated than it needs to be.